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Life Insurance and the Macroeconomy

It has been observed that there is a significant relationship between the demand for life insurance and various macroeconomic variables. High growth of GDP induces an economic effect through higher per capita and disposable income and savings, which in turn create a favourable market demand for life insurance. On the other hand, life insurance also provides support to the capital market and savings data pertaining to Indian life insurance and macroeconomic variables broadly indicate a close relationship and interdependence between macroeconomic variables and life insurance demand.

Life Insurance and the Macroeconomy

Indian Experience

It has been observed that there is a significant relationship between the demand for life insurance and various macroeconomic variables. High growth of GDP induces an economic effect through higher per capita and disposable income and savings, which in turn create a favourable market demand for life insurance. On the other hand, life insurance also provides support to the capital market and savings data pertaining to Indian life insurance and macroeconomic variables broadly indicate a close relationship and interdependence between macroeconomic variables and life insurance demand.

H SADHAK

T
he life insurance business is significantly influenced by the state of the economy of a country and major factors that influence it are the rate of growth of GDP, the levels of domestic savings, household financial savings, disposable income, etc. The size of the life insurance market is also influenced by the rate of growth of population, social security and healthcare systems, changes in customs, social practices, risks etc. It has been observed that societies in which the standard of living has been steadily improving experience a higher insurance penetration. Market competition exerts a very positive influence on market expansion, life insurance penetration as well as insurance density. The recent upsurge in the Indian economy and market reforms leading to competition have created tremendous opportunities for the growth of the life insurance industry. In this article an attempt has been made to focus on some key factors of the growth of the Indian life insurance industry in the context of emerging macroeconomic changes.

I Determinants of Life Insurance Demand

The determinants of insurance demand and the inter-relationship between insurance and economic growth have been examined by many eminent authors like Outréville (1996), Cargill and Troxel (1979) Babbel (1985) Browne and Kim (1993), Rubayah and Zaidi (2000), Damian Ward and Ralf Zurbruegg (2000). Outréville’s work is notable for establishing the links between development of the insurance market and the development of the financial sector in the economy. He observed that the levels of financial development directly affect the development of the life insurance sector.

Ward and Zurbruegg (2000) studied the relationship between development of the insurance sector and the growth of the economy. The empirical analysis by Ward and Zurbruegg, however, suggest that the role of insurance in the economy may vary across countries. They observed that growth in the insurance sector can potentially have an effect on economic growth via the short run dynamics of the lagged premium terms in the restricted variance, through the long-run equilibrium relationship between the markets, or both. They found this relationship in many countries like Australia, Canada, France, Italy, Japan, etc. Studies conducted by these authors have also identified the major macroeconomic and other factors impacting the demand for life insurance. Accordingly, the major macroeconomic factors are the income level (per capita and disposable income), inflation and price level, price of insurance, comparative return on investment of life insurance, demographic factors, etc.

The income level has a very strong influence on life insurance demand in any country. The study of Cargill and Troxel (1979) and Babbel (1985), studied the impact of income levels on life insurance by using disposable personal income, income per capita and found that there exists a very positive relationship between income level and insurance demand.

However, inflation has a very negative effect on the demand for life insurance. It has been observed by Browne and Kim, Outreville, Cargill and Troxel that high inflation exert a very strong dampening effect on life insurance demand because of a rise in the cost of living which makes life insurance purchase costlier and less attractive. These authors have also examined the relationships between the return on life insurance and the yields on the competitive savings products. Cargill and Troxel (1979) observed that a higher interest rate on alternative savings products tends to make insurance products less attractive on the other hand a higher rate of return on life insurance tends to attract individuals to purchase insurance from them.

The price of insurance also has an important influence on the demand for life insurance as noted by Rubayah and Zaidi and Lim and Haberman. They observed that the price of insurance is significantly and inversely related to the demand for life insurance. A higher insurance cost is a discouraging factor for the demand for life insurance. Lim and Haberman have also noted that the elasticity of demand with respect to price change is 1.115. The demand for life insurance tends to have a greater magnitude of change when there is a small change in the price of insurance. A small percentage reduction in price would help to increase the demand for life insurance.

Among the other factors, life expectancy at birth plays an important role in influencing the growth and demand for life insurance in a country. A higher life expectancy at birth plays an important positive role in influencing the demand for life insurance. A higher life expectancy is positively related to the life insurance demand.

The factors mentioned above as determinants of life insurance growth are the fundamental macroeconomic factors and form the linkages between the economy and the life insurance market. Life insurance is an important intermediary in the financial market,

Economic and Political Weekly March 18, 2006

and also plays a very important role in the economy by mobilising savings and supplying long-term capital for economic growth and as an asset allocator. Life insurance as a financial intermediary contributes significantly to promoting the capital market. The pattern of asset allocation of any life insurance company among the financial instruments provides a significant insight into its support to various segments of the market. Further, in a competitive insurance market, competition among the insurers increases productive efficiency, provides investors with diversified portfolio choice, enhances liquidity and induces better monitoring and corporate governance. They also facilitate risk sharing by reducing transaction cost and diversification of investment portfolios. A strong life insurance industry promotes a developed contractual savings sector which “contributes to a more resilient economy, one that would be less vulnerable to interest rate and demand shocks, while creating a more stable business environment, including macroeconomic stability. The result will be a lower country risk premium, hence equilibrium interest rates which increase investment and ultimately accelerate growth” [Catalan 2000].

II Growth of Life Insurance in India

During recent times, the Indian economy has been performing well and the momentum of growth has picked up particularly since liberalisation was initiated in the 1990s. Though the overall growth rate during the last decade has fluctuated, yet it remained well above many emerging economies of the world. With further reforms initiated in the early 1990s, there has been a significant structural change in the macroeconomy and in the process the service sector has emerged as the leading sector and engine of growth.

India is one of the countries in the world which has achieved a high growth rate in domestic savings, and a higher propensity to save by the household sector has been maintained over the period. During 2001-02 to 2004-05 the average gross domestic savings (GDS) as a percentage of GDP was 25.8 per cent as against 23 per cent during 1998-99 to 2000-01. In spite of a marginal fall in savings from 24.2 per cent in 1998-99 to 23.5 per cent in 2001-02, the share of the household sector in GDS increased steadily 20.9 per cent in 1999-2000 to 24.3 per cent in 2003-04. The positive growth in the economy, expansion of the service sector and increase in household savings all contributed significantly to the high growth of domestic savings.

Another significant aspect of household savings is the continued preference for insurance products. Life insurance savings in India have been steadily increasing. While the share of bank deposits and provident funds has fluctuated and declined in the household financial assets, the share of insurance funds has increased steadily from 8.7 per cent in 1993-94 to 12.1 per cent in 1999-2000. Further, in 2002-03, 15 per cent of financial assets were in life insurance funds.

However, since then the share of insurance funds in household savings has declined to 13.5 per cent in 2003-04 and to 13 per cent in 2004-05. In terms of GDP, the share of insurance funds went up from 1.5 per cent in 1999-2000 to 2.1 per cent in 2002-03 but declined to 1.8 per cent in 2004-05.

Indian life insurance, since nationalisation, has registered a very significant growth and gradually increased its share in household financial savings. Growth of insurance can be seen in terms of growth of life funds assets, number of policyholders and premium income. Growth in life funds is considered to be an important indicator of growth of life insurance industry and as can be seen from the Table 1.

A high growth of life funds and assets of LIC was possible due to a significant growth in new business, which got a boost during the post insurance liberalisation period. For the first time, in 1999, LIC sold more than one crore (1.48 core) policies in a single year and in 2002 it crossed the two crore mark (2.25 crore), which increased further to 2.65 in crore in 2003. Similarly, new business of LIC increased from Rs 337.45 crore in 1958 to Rs 75,316.28 crore in 1999. However, growth became faster during the post liberalisation period and new business had gone up from Rs 75,316.28 crore in 1989 to Rs 1,98,707 crore in 2004 (Table 2). LIC started with Rs 1,524 crore of sum assured with

59.74 lakh policies in force which went upto Rs 3,68,496 crore under 916 lakh policies. This, however, increased significantly to Rs 9,25,033 crore under 1,539 lakh policies.

An overall view of the Indian life insurance market can be obtained through data released by IRDA, shown in the Tables 3 and 4. Accordingly, the total number of policies underwritten by Indian life insurance went up from 2.54 crore in 2002-03 to

2.62 crore in 2004-05. While the premium under these policies went up from Rs 12,325 crore to Rs 25,343 crore during the same period with the increased competition and growth in market size. There is, however, a fall in the market share of LIC in new business. In terms of the number of policies, the market share of LIC declined from 96.70 per cent to 91.50 per cent while in premium income the market share of LIC declined from 92.03 per cent to 78.07 per cent during the same period.

Table 1: Life Fund and Assets of LIC of India

(Rs crore)

Year Life Fund Assets

1958 410.40 463.0 1967 1123.90 1247.54 1970 1611.03 1771.78 1980 5818.09 6176.93 1990 23471.84 24418.75 1999 127389.06 132764.39 2001 186024.75 193283.0 2002 227008.98 242659.61 2003 273004.96 290540 2004 321753.53 367360

Source: LIC Annual Reports (various issues).

Table 2: Life Insurance Business of LIC of India

Year New Business Business Inforce No of Sum No of Sum Policies Assured Policies Assured

(in Lakh) (in Rs Crore) (in Lakh) (in Rs Crore)

1958 9.30 337.45 59.74 1523.67 1967 14.06 757.94 119.98 4338.94 1970 13.97 1025.8 139.39 5781.2 1980 20.96 2733.11 220.39 17234.24 1990 73.92 23279.53 403.39 81413.95 1999 148.44 75316.28 916.37 368496.1

Post-Insurance Liberalisation

2000 169.78 91214.25 1012.99 534589 2001 196.57 124771.62 1130.24 522621.5 2002 224.91 192572.27 1257.89 668131.2 2003 242.68 179512.22 1387.88 954500.7 2004 264.56 198707.12 1539.21 925033.3

Source: LIC Annual Reports (various issues).

Economic and Political Weekly March 18, 2006

Chart 1: Growth Rate of GDP, Gross Domestic Savings and LifeChart 2: Growth Rate of Gross Domestic Savings, HouseholdInsurance Funds (Premium) Savings and Life Insurance Premium (Funds )

--------50.00 40.00 30.00 20.00 10.00 0.00 –10.00 –20.00 –30.00 –40.00 1951-521955-561959-601963-641967-681971-721975-761979-801983-841987-881989-901991-921993-941995-961997-981999-002000-012001-022002-032003-04 50 40 30 20 10 0 –10 –20 –30 –40 LI Funds HHS GDS 1951-521955-561959-601963-641967-681971-721975-761979-801983-841987-881989-901991-921993-941995-961997-981999-002000-012001-022002-032003-04

-Gross Domestic Product Gross Domestic Savings . Life Insurance Premium (Funds)

It can be mentioned here that in general the opening of the market has not provided much momentum to the growth of industry though there had been some elements of competition and expansion of product range. During the post liberalisation period, the average growth rate in policies during 2002-03 to 2004-05 was merely 5.4 per cent as against 14.9 per cent during 1999-2000 to 2001-02 (Table 5). Similarly, the growth rate in new business premium income was 19.7 per cent as against 81 per cent. The growth rate in premium income was of 137 per cent in 2001-02 which disproportionately influenced the post insurance liberalisation average growth and was an aberration. If we exclude this aberration, the growth rate seems to be better during the pre-liberalisation period.

III Interdependence of GDP, Household Savings and Life Insurance Funds

High GDS have been strongly supported by savings in the household sector. Overall growth in GDP and household savings have significantly influenced the growth of Indian life insurance business. In fact, the growth of LIC’s premium income in general has been higher than the growth rate in GDP, except during the last two years when it was lower than that in 2001-02. Further, if we add the premium income of other private insurance companies, growth rates are higher than shown below. This leads us to the crucial question about the nature of relationship between macroeconomic growth and development of the insurance industry.

A new dimension of this relationship has been opened up by financial liberalisation and reforms in the Indian insurance sector. Reforms and liberalisation are expected to exert a significant impact on income, savings and insurance purchase; financial reforms are expected to improve allocation of savings and insurance reform is expected to increase savings. We have made an attempt to examine the relationships between various macroeconomic variables and life insurance purchase by the household sector and also the impact of financial liberalisation and insurance sector reform. Pearson correlation matrix analysis has been carried out with the help of data relating to GDP, personal disposable income(PDY) household financial savings and the share of life insurance funds in household financial savings to examine the impact of these factors on life insurance purchase. Since life insurance purchase is also influenced by the rate of inflation, rate of interest and return from alternative investment, we have selected yearly inflation rate for industrial workers, above five years deposit rates of commercial banks, dividend on units of

-Gross Domestic Savings Household Savings . Life Insurance Premium (Funds)

UTI and return and gross return on life insurance funds (LIC). Finally, growth of population is expected to be directly related to the sales growth of life insurance. We have therefore, carried out the pearson correlation matrix analysis for population and the sum assured. The findings are in general quite significant and reveal a strong relationship between life insurance demand and various macroeconomic variables.

GDP growth is a reflection of overall growth of economy, which has its impact on disposable income, savings and consumption. A high growth rate is expected to boost savings and thus support a higher demand for financial instruments by the household sector. It can be observed from Chart 1, that GDP has influenced higher savings and life insurance funds. However, during the post liberalisation period, life insurance funds could not keep pace with GDP and GDS.

Table 3: Post-Insurance Liberalisation Insurance Market: Premium Income (New Business)

Insurer 2002-03 2003-04 2004-05
Total Market Total Market Total Market
(Rs lakh) Share (Rs lakh) Share (Rs lakh) Share

I LIC 1134299.12 92.03 1628468.67 87.04 1978593.20 78.07 II Private

insurer 98184.25 7.97 242547.35 12.96 555694.47 21.93 III Total 1232483.37 100.00 1871016.02 100.00 2534287.67 100.00

Source: IRDA Journal (various Issues).

Table 4: Post-Insurance Liberalisation Insurance Market: Policies (New Business)

Insurer 2002-03 2003-04 2004-05 Total Market Total Market Total Market (Rs lakh) Share (Rs lakh) Share (Rs lakh) Share

I LIC 24545583 96.70 26968069 94.21 24027393 91.50 II Private

insurer 837107 3.30 1658846 5.79 2233075 8.50 III Total 25382690 100.00 28626915 100.00 26260468 100.00

Source: IRDA Journal (various Issues).

Table 5: Growth Rates in Life Insurance Policies and Premium Income

(Per cent)

Policies Premium Income
1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 14.37 15.79 14.42 11.62 12.78 -8.27 41.08 64.92 137.11 -28.11 51.81 35.45

Economic and Political Weekly March 18, 2006

Chart 3: Personal Disposable Income, Household Savings,Savings in Financial Assets and Life Insurance

2500000 2000000 1500000 1000000 500000 0

1950-511955-561960-611965-661970-711975-761980-811985-861990-911995-962000-012001-922002-032003-04

-Personal Disposable Income (PDY) Savings of Household Sector (HS) . Household Savings in Fin Assets Life Insurance Fund

A closer look at Chart 2 will reveal that household savings have mostly followed gross domestic savings; it is because the other sectors, i e, public, private and corporate sector have minimal role in domestic savings. It can be observed that the contribution of the private sector to savings is around 4 per cent (in GDP terms) while that of the public sector is negative since 1999-2000. However, growth in life insurance funds (premium) though following the growth trend of household savings, has remained much below household savings. Therefore, one of the concerns is the gradual decline of the share of insurance premium (life funds) in household financial savings which has declined from 16.5 per cent in 2002-03 to 13 per cent in 2004-05.

It can also be observed that growth in life insurance funds since 2001-02 could not keep pace with the growth of household savings. Opening up of the insurance market to the private players has not been able to cause any intensive penetration.

In order to examine the extent of relationship among the above selected variables (GDP, GDS and HDS) with life insurance funds, Pearson correlation analysis was carried out and the analysis indicates (Table 6) that overall there are very strong positive correlations among the selected variables with the life insurance fund. Also the correlations were statistically significant at 1 per cent significance level. Among the variables household domestic savings appear to have very high correlation (.992) with life insurance funds, followed by gross domestic savings (.981) and gross domestic product (.977) and all were highly significant at 1 per cent level of significance. All these indicate that an increase in savings and national productivity has a direct impact (positive) on the life insurance sale.

Relationships between Disposable Income, Savings and Life Insurance Funds

Personal disposable income is another important variable determining the growth of the life insurance market. We have, therefore, examined this issue and also carried out correlation analysis.

Personal disposable income arrived at after deduction of payment of direct taxes and other miscellaneous receipts of the government from personal income. (PDY is distributed between household savings and private final consumption.)

Savings as percentage of PDY was 14.5 per cent in 1950-51 but declined to 3.6 per cent in 2002-03. Therefore, in relative terms though savings volume increased during 1950-51 to 2002-03, more and more funds from PDY were diverted to private final consumption leaving a small amount to be saved from PDY. This also affected the growth of life insurance funds, which failed to keep pace with PDY (Chart 3).

Table 6: Correlation Matrix of Selected Variables: GDP, GDS, HDS and Life Insurance Funds (1980-81 to 2003-04)

Gross Gross Household Life Domestic Domestic Domestic Insurance Product Savings Savings Fund

(GDP) (GDS) (HDS)

GDP 1 .995 .992 .977 GDS 1 .997 .981 HDS .992 .997 1 .992 Life fund .977 .981 .992 1

Note: The above coefficients are significant at 1per cent level of significance.

Table 7: Correlation Matrix of Income, Savings and Life Insurance Funds (1980-81 to 2003-04)

Personal Household Household Life Disposable Savings Savings Insurance Income (HS) in Fin Assets Fund (PDI) (HSFA)

PDI 1 .997 .998 .991 HS .997 1 .999 .988 HSFA .998 .999 1 .990 Life fund .991 .988 .990 1

Note: The above coefficients are significant at 1 per cent level of significance.

Table 8: Correlation Matrix of Inflation, Interest Rate and Insurance

CPI UTI BANKINT LICRATE LICSAV FYPGrow

CPI 1 .494* .659* .360** .086 .215 UTI .494* 1 .361 .457** .060 .695* BANKINT .659* .361 1 .461* .170 .034* LICRATE .360** .457** .461* 1 .304** .292 LICSAV .086 .060 .170 .304 1 .010

(N) 19 16 19 19 19 22

* Correlation is significant at the 0.05 level. ** Correlation is significant at the 0.1 level. N indicates sample size UTI is dividend on units, Bank int is interest rate, CPI is consumer price inflation.

Table 9: Correlations of Inflation, Interest Rate and Life Insurance Premium (New Business)

CPI UTI BANKINT PREMIUM
CPI UTI BANKINT PREMIUM N 1 .494* .659** -.524* 20 .494* 1 .361 -.246 17 .659** .361 1 -.696** 20 -.524* -.246 -.696** 1 25

* Correlation is significant at the 0.05 level. ** Correlation is significant at the 0.01 level. N indicates Sample Size Premium is insurance premium (new business), rest as in Table 8.

Table 10: Correlations of Population Growth with Life Insurance(1980-81 to 2003-04)

POPULN PREMIUM NBPOLICY
POPULN PREMIUM NBPOLICY N 1 .867** .913** 30 .867** 1 .979** 25 .913** .979** 1 30

** Correlation is significant at the 0.01 level (2-tailed). POPULN is population growth, Premium is new business, and NBPOLICY is new policies. N indicates sample size.

Economic and Political Weekly March 18, 2006

However there seem to be strong relationships among these factors, when correlation analysis was carried out with data relating to personal disposable income (PDI), household savings (HDS), household savings in financial assets (HSFA) and life insurance funds. Our analysis indicates overall that there are very strong positive correlations among the selected variables with the life insurance fund and the correlations were statistically significant at 1 per cent significance level (Table 7). Among the variables PDI (.991) and HSFA (.990) appear to have very high correlation with life insurance funds, followed by HDS (.988) and all were highly significant at the 1 per cent level of significance. All these indicate that PDI and household investment in financial assets have a strong impact (positive) on the life insurance sale.

Inflation, Interest Rate and Life Insurance Growth

Inflation is expected to have a negative correlation with life insurance demand since it exerts a damping effect, because high inflation pushes up the cost of living thus making insurance purchase less attractive. The rank correlations in Table 8 show the relationship between inflation, interest rates and insurance funds.

Since life insurance as a percentage of HDS did not have a significant relationship with the above variables, life insurance premium (new business) was selected and the result is given in Table 9.

The impact of inflation interest rates, return from alternate investment and life insurance has been studied with the help of the annualised consumer price index for industrial workers, and deposit rates of commercial banks. The rate of interest realised on mean life fund of LIC, UTI dividend rates. Correlation analysis indicated a strong correlations between the variables, particularly consumer price index (-.524), and bank interest rate (-.696). UTI dividends (-.246) have a negative correlation with life insurance premium (new business) as expected. Of the selected variables, bank interest has greater negative correlation with life insurance business, followed by CPI, while UTI dividend has a low correlation. Thus, when the bank interest rate and inflation decrease, the life insurance (new business) increases. Similarly there is a moderate correlation between the LIC’s return and the CPI (.360), bank interest (.461) and UTI dividends (.457).

Population Growth and Life Insurance

Population growth is expected to have a positive relationship with life insurance growth. The results of the Pearson correlation analysis with population, life insurance premium (new business), and number of policies (new business) for the period 1981 to 2005 are presented in Table 10.

The analysis indicates a very strong correlation with the selected variables, particularly life insurance new business, both premium income (.867) and number of policies (.913) seem to have very strong correlations with population growth.

Conclusion

It has been observed that there is a very significant relationship between the demand for life insurance and various macroeconomic variables. High growth of GDP induces an economic effect through higher per capita and disposable income and savings, which in turn create a favourable market demand for life insurance. On the other hand, life insurance also provides support to the capital market and savings data pertaining to Indian life insurance and macroeconomic variables broadly indicate a close relationship and interdependence between macroeconomic variables and life insurance demand.

However, it has also been observed that in India, while the economy in general and disposable income and savings in particular have registered a significant growth, life insurance demand has not picked up (or alternatively the life insurance industry could not capitalise on the growth of income and savings). Therefore, in order to capitalise the growth potential particularly in the postliberalised economy, concerted efforts need to be made to spread financial literacy, to create awareness about personal financial risk management, marketing driven distribution management, customer focused service management and technology and knowledge-based funds management.

The insurance market in India has switched over from supplyled to a demand-led market and an upsurge in multi-product and multi-institution competition. Understanding this emerging market dynamics and institutionalising it in a futuristic corporate policy will enable insurance companies to capitalise on the growth potential.

m

Email: hsadhak@rediffmail.com

[The views expressed are of the author. The author is grateful to S Doss, for statistical analysis.]

References

Babbel, D F (1985): ‘The Price Elasticity of Demand and for Whole Life Insurance’, The Journal of Finance, Vol 40, No 1. Browne, M J and K Kim (1993): ‘An International Analysis of Life Insurance Demand’, Journal of Risk Insurance, Vol 60, No 4. Cargill T F and T E Troxel (1979): ‘Modelling Life Insurance Savings: Some Methodological Issues’, The Journal of Risk and Insurance, Vol 46, No 2.

Catalan Mario, Gregoria Impavido and R Alberto Musalem (2000): ‘Contractual Savings or Stock Markets Development: Which Leads?’ Financial Sector Development, World Bank, August.

Dolar, Veronika and Cesaire Meh (2002): ‘Financial Structure and Economic Growth? A Non-Technical Survey’, Working paper 2002-24, Bank of Canada.

Lim, Che Che and Steven Haberman: ‘Macroeconomics Variables and the Demand for Life Insurance in Malaysia’. www.cass.city.ac.uk/conference/ oxmetrics2003/LimHabermanABS.PDF

Outreville, J F (1996): ‘Life Insurance Market in Developing Countries’, Journal of Risk and Insurance, Vol 63, No 2. Rubayah and Zaidi (2000): ‘Prospek Industries Insurance’, International Insurance Monitor, Vol 36, No 6.

Ward, Damian and Ralf Zurbruegg (2000): ‘Does Insurance Promote Economic Growth? Evidence from OECD Countries’, The Journal of Risk and Insurance, Vol 67, pp 489-506.

Economic and Political Weekly March 18, 2006

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